Shocked by what it called unfair arguments by the Internal Revenue Service, the U.S. Court of Appeals for the 8th Circuit reversed a Tax Court decision that a taxpayer did not make a timely rollover to his individual retirement account from which he made several IRA distributions during the year. (Harry Robert Haury v. Commissioner, Court of Appeals 8th Circuit, No. 13-1780, May 12, 2014.)
This case highlights that even the IRS and the Tax Court sometimes make mistakes on IRA rollover rules.
In 2007, Harry Haury, a software engineer, had some cash flow problems related to two companies that he owned and served as CEO and president of. To get cash, he took four distributions from his IRA in 2007, which were transferred to his companies. The IRA distributions and contributions for 2007 were as follows:
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On April 30, 2007, one of his companies sent a check for $120,000 to the IRA trustee which Mr. Haury rolled over into his IRA.
Mr. Haury didn't file a federal income tax return for 2007. The IRS responded by preparing a substitute return for him and issuing a notice of deficiency for unpaid taxes, penalties (for failing to file a tax return, timely pay tax, and pay estimated taxes), and interest of more than $275,000. The deficiency asserted, among other things, that taxes were owed on $434,964 of IRA distributions. Mr. Haury disagreed with the IRS and responded by filing a tax return for 2007 that reported taxable IRA distributions of $120,000 less than the IRS amount and taking his case to the Tax Court, where he represented himself.
At trial, Mr. Haury conceded that he received over $434,000 in IRA distributions but argued that $120,000 deposited into his IRA on April 30,2007 was a valid rollover and thus not taxable. Because he was defending himself in court and wasn't an expert on the IRA rules, he didn't specify which IRA distribution was being rolled over.
But the IRS didn't see it that way. Seizing on the fact that the $120,000 April 30 contribution matched the Feb. 15 IRA distribution, the IRS argued that it wasn't a timely rollover because it was made after 60-days from Feb. 15 (i.e., actually 74 days had passed from Feb. 15 through April 30).
The Tax Court agreed with the IRS and ruled that the $120,000 was not a valid rollover because it was deposited into his IRA more than 60 days after it was distributed from the Feb. 15 distribution. (Harry R. Haury v. Commissioner, TC Memo 2012-215, July 30, 2012)
EARLY WITHDRAWAL PENALTY
Also because Mr. Haury was under age 59 ½ at the time, the entire $434,964 was also subject to the 10% early distribution penalty because no exception to the penalty applied.
Mr. Haury appealed, challenging the Tax Court's IRA rollover treatment. The issue was whether the contribution was a valid rollover that would reduce his taxable income by $120,000.
Appeals Court Says Rollover Was Timely
For the appeals court trial, Mr. Haury finally hired a lawyer, and that proved to be a smart move. The court reversed the Tax Court's ruling and agreed with Mr. Haury that the $120,000 contribution was a valid rollover.
Mr. Haury's lawyer argued that the April 30 $120,000 IRA contribution was a timely partial rollover of the $168,000 April 9 IRA distribution. Because this rollover was well within 60 days, it should be treated as a valid tax-free rollover.
The IRS' lawyer reluctantly acknowledged at oral argument that the 60-day limit was satisfied, but argued that the partial rollover was forfeited because Mr. Haury failed to argue it to the Tax Court. The appeals court found this argument revolting, stating “Frankly, we are appalled by the unfairness of this contention.”
Neither the IRS nor the Tax Court even considered the possibility of a partial rollover of the April 9 IRA distribution.
Because the appeals court found that Mr. Haury's April 30, 2007 $120,000 rollover was made well within 60 days of the April 9 $168,000 IRA distribution, it was a timely rollover and thus Mr. Haury was entitled to reduce his 2007 IRA distributions by $120,000. The result was that $120,000 was not taxable or subject to the 10% early distribution penalty. The Tax Court's prior ruling was reversed.
Advisers should know that partial IRA rollovers are allowed and can help clients who may need some, but not all of an IRA distribution in a cash crunch, as was the case here. There is no requirement to roll over an entire IRA distribution.
Note: Beginning Jan. 1, 2015, IRS tax rules no longer allow more than one IRA to IRA 60-day rollover per year.
Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group. He can be reached at irahelp.com.
